To: José María Alvarez-Pallete

From:

Re: Telefonica Competitive Position and Analysis

Date: December 23, 2017

In response to our conversation on December 1, I have prepared a strategic analysis to assess the current competitive
position of Telefonica in the telecommunications industry. As you are aware, the telecommunication industry is
intensely competitive worldwide, even for an oligopoly and Spain’s telecom market in recent years has fallen steadily,
with the sector affected by the poor economic climate exacerbated by high unemployment and reduced disposable
income among consumers. However, a five-year recession, effectively ended in 2014 when the economy showed a
steady return to growth and this has been sustained since then: growing confidence among investors has been
palpable since 2015. The improved business climate should augur well for the sector into 2018. Having said that, is
Telefonica in a competitive position to begin and end 2018 with success?

Industry Analysis

The telecommunications industry is part of the Information and Communication(s) Technology industry. In this
industry, the companies’ main activity is the development, production, sale or intensive use of information and
communication technology. The industry´s structure is formed by manufacturer and services companies. On the one
hand the manufacturer enterprises are dedicated, to the assembly of electronic devices, circuits and computer
components, and on the other hand to the 2 design and production of telecommunication equipment, telephones and
multimedia devices. During last years these companies had to make great changes in their business strategies and
focus on the development, design and generation of telecommunication equipment like Digital Terrestrial Television
(DTT) or consumer electronics (Smartphones, laptops, etc.). The structure follows with the services enterprises that
are divided in three different categories: Commerce, information technology activities and telecommunications. The
companies of the last group are composed by installation firms, network capacity resellers, integrated
telecommunication advisers and public network service suppliers. As it is shown, the ICT sector is too wide and complex
to be entirely analyzed, and because we are analyzing Telefonica, a Spanish firm, we will be focused on the Spanish
telecommunication sector. The telecommunications industry includes all the companies that offer communication
services using the last generation technology by telecommunication operators and other telecommunication activities.

The Spanish market has three main operators (Telefonica, Orange and Vodafone) delivering fixed-mobile services
nationwide. Másmovil delivers mobile services, while Euskaltel and Telecable (owned by Zegona) are cable operators
delivering fixed-mobile services only to the north of Spain (Basque Country, Galicia and Asturias). Spain has 13.8m
broadband lines, of which 5.0m are delivered through fiber-to-the-home (FTTH) networks, 2.5m are cable lines and
6.3m uses copper networks (xDSL). Total mobile lines are 51.2m, of which 39.8m include data.
Exhibit 1: The fixed market is led by Telefonica, while the mobile market is more equally split between operators

Source: Comisión Nacional de los Mercados y la Competencia (CNMC)

Telefonica has the advantage of being the leader on both markets (fixed and mobile) however the competition is high,
and specially in mobile market with portability available, the power of consumers is also high, they are price sensitive.

For the Spanish telecommunication sector´s analysis the environment will be studied for a clear determination of the
industry attractiveness. The environment is formed by all those factors that affect the companies but are out of their
control. These factors cannot be manipulated by the companies but they have a significant influence on the business
strategy, decisions and results. We are going to do a general environmental analysis using PESTLE and specific
analysis using Porter’s Five Forces.

PESTLE Analysis:

 Political dimension: The Spanish government, in an attempt to face the crisis, took many restrictive fiscal
policies that affect directly the ICT sector, therefore the telecommunication industry. Among them the tax rise could
be one of the most harmful for the sector. A tax rise means that the consumers will have less purchasing power and
taking into account that the telecommunication services are not basic need products, the companies from the sector
could suffer a severe reduction of sales. Also, in 2013 the government created a policy to encourage ICT companies to
improve and reach the European level of this sector. The government offers to the actual and new companies in the
sector subsidies and special funding programs
 Economic dimension: The economic crisis set off many unfavorable situations in the Spanish market. Among
those situations the high unemployment is one of the worst, however, is decreasing as time passes (Exhibit 2). At the
same time the salaries were reduced and thereby the savings and purchase power have decreased in a significant way.
All this generated a contraction in the consume that affected the incomings of the businesses and worsened the
Spanish economic situation. It has been shown in the industry´s definition that the consumption of voice transmission
and text messages suffered a drop on their consumption. This drop is directly related to the diminution of the
consumer´s purchase power
Exhibit 2: Spain Unemployed Rate - Evolution

Source: Trading Economics

 Social dimension: This dimension has had a big impact for the last years on the telecommunication sector
because of the rise of the internet as a communication tool. The use of the internet in smartphones had different and
harmful consequences for the companies that compete in the telecommunication industry, especially for the
telecommunication operators. The use of smartphones for communication has increased during the last year and as a
consequence the landlines suffered a drop in their use. The Spanish population substituted the landlines for mobile
phone lines, even some people decided to renounce the house landline and only use the mobile phone. Another bad
consequence is the substitution of voice transmission and text messages for instant messaging or free voice
communication applications by internet. This new trend caused an important drop of the telecommunication
operator´s incomings and supposes a reconsideration of business strategy for the companies of the industry. For
companies this trend is not only a threat, but an opportunity for selling new services and many companies have already
started to use it as such. Voice has reached its end, Data is the now and the future
 Technological dimension: The innovation and knowhow are the two factors that always are in development in
this industry, and the companies cannot allow themselves to be phased out in the telecommunication sector.
 Legal dimension: The most notorious factors in this dimension are the last labor law and the new General Law
of Telecommunications. The last labor law in one hand, reduces the rights of the employees in the Spanish market
generating tension between the workers and the management. On the other hand, will focus on a social and territorial
cohesion making the State collaborate to help the telecommunication operators spreading their networks and
investing on the industry in an easier way (Spain, Ley 9/2014, de 9 de mayo, de Telecomunicaciones).
 Environment dimension: This dimension has become of great importance for the last years, sometimes being
decisive for the buyers. This had made the companies develop social awareness and take some ecologic measures like
using renewable energies or waste processing.
With the six dimensions analyzed a general environment matrix can be drawn. In this matrix it will be shown the scale
of influence of these factors on the telecommunication industry. This way it will be easier for the companies in the
industry to react to these factors that cannot be avoided. They could take advantage of the positive factors and react
quickly to those that could damage the company. As the Exhibit 3 shows, the telecommunication industry is very
sensitive to the general environment´s factor.

Exhibit 3: PESTLE Analysis

Factors Very Negative Negative Indifferent Positive Very Positive

Tax Rise X
Polit.

Subsidies X

Funding Help X

Economic Crisis X

X
Unemployment
Econ.

X
Low Savings

X
Consume Attraction

Less Use of Landlines X

Instant Messaging X
Social

Voice Trans Substitution X

Business Opportunity X

Innovation X
Tech.

Know How X

Labor Law X
Legal

New General Telec. Law X

Ecol.

Social Awareness X
Porter´s Five Forces Analysis

Using this analysis we study the factors that are directly related with the business activity and affect only to the
companies that compete in the telecommunications sector.

Exhibit 4. Porter´s Five Forces

Entry
 Investment: the companies needs
high investment in high technology
devices, equipment and network
cover.
 Fix Costs: the investment is also
needed for maintaining every year
the equipment and networks as well
 Know-How: Companies that work
in the industry already have that
useful Know-How that helps them to
work efficiently.

Suppliers: Rivalry: Buyers

They provide infrastructures to make  High rivalry in an industry In the telecommunication industry
possible all the activities from the overexploited there is not one differentiated
telecom companies. These  Large number of small companies product and the companies offer
companies are not big in number and in addition begin to take market very similar services and prices to the
the products they sell are necessary share from larger companies customers. Therefore, the
for the telecom companies to  Telefonica maintained in recent bargaining power of the customers is
provide services to the customers. years the market leadership high. They can find the same or even
That is why their bargain power is position, and is the main objective of better offers in other companies and
very high. its competitors to detract customers they would go to them easily.
Substitutes and Complements:
Years ago it seemed that the mobile
phone line would substitute the
landline. Nowadays it is not seen in
such way anymore, since companies
offer both services, even as a service
pack
Strategic Groups & Positioning

A strategic group is a group of companies that follow the same or very similar strategy based in two of these possible
dimensions: Product line, geographic limits, distribution channels, quality, price policy, costs, technology, customer
service, etc. In the analysis of the Telecommunication sector, we have identified three strategic groups that gather up
different companies following a similar strategy (Exhibit 5):

 Wholesaler of telecommunication operator services: this group is formed by the companies that offer
connection services to retailers so they can provide services to the customers. These companies use a strategy based
on the use of the latest technology and high investments in it. They provide services to retailers with millions of
customers and the equipment they use must have enough capacity to deal with such intensive consume. These
companies are big in size with big budgets but there are only a few in the Spanish market. Telefonica, for example, is
one of the companies in this Strategic Group.
 Retailer of telecommunication operator services: in this group there are telecommunication operator
companies that offer a service of telecommunication (landline, mobile phone line, internet, etc.) to the customers. The
strategy of this Strategic Group is a high investment and use of high technology to provide services to the final
consumer. This group gathers up companies like ONO or Jazztel.
 Companies dedicated to other services: finally, the last group is formed by all those small or medium
companies in the telecommunication industry that follow a business strategy based in medium-low technology and
low investment. Those companies are mainly firms dedicated to installation, network capacity resell, integrated
telecommunication advice and public network service supply.

Exhibit 5: Strategic Groups of the Telecommunication Industry

Each circle represents a type of company that follow a determined business strategy. The size of the circle shows the
number of companies gathered up in it and their locations depend on the use of the dimensions

Source: Deloitte, Nuevos retos y estrategias, Newsletter 2013

Exhibit 5 shows that when it comes to investment and technology the companies on the sector follow three different
strategies, in one hand, two of them focusing on high investment and high technology and these companies are few
in number (since they required big budgets to offer a wide line of service and a wide cover) On the other hand, the
companies dedicated to other telecommunication activities use much less investment and do not need to use high
technology as the other two Strategic Groups. Those companies are of small and medium size and some of them work
in local or regional areas, but the graph shows that there is a large number of them in the industry.

Competitor Analysis

Even though we have shown that Telefonica leads the mobile and fixed marked in Spain, (Exhibit 1), the current trend
shows that competitors are gradually gaining more market share and Telefonica is losing it (Exhibit 6) due to regulatory
changes, expansion and operation spectrum primarily due to aggressive publicity campaigns and make the customer,
so far faithful to brand, to change Mobile phone operator.

Exhibit 6: Telefonica's mobile market share worldwide by country from 2012 to 2016

Source: Statista

No doubt, many of these consequences are the terminal funding policies. Telefonica and Vodafone decided to stop
economic assistance in the purchase of these devices. Orange, as the third largest company in the market, decided to
maintain the policy and has been a big winner on this decision the best results for customer acquisition portability.

Very to consider is the entry into the MVNO (Mobile Virtual Network Operator) market with very competitive prices
that make your customer acquisition focus especially on the younger population. For business lines, Telefonica
maintains its leadership role by conducting customer loyalty policy, either by adjusting prices, with discounts or
company providing global solutions.

Competitive Positioning

Focusing on data changes in the number of mobile phone lines in Spain in the period 1997 - 2013 (millions of lines),
in 2013, the number of mobile phone lines for personal communication was 55.195K, with the penetration rate of
1,53 lines per habitants.
Exhibit 6: Spain’s mobile users - Evolution

Source: Ditrendia

There are four operators with their own network (i.e., they manage their own mobile phone masts), although the last
to arrive (Yoigo / Telstra), has an agreement to use Movistar network also, because it still is deploying its own network.
There are also a number of mobile virtual network operators of around twenty.

The mobile phone market in Spain in January 2016 was formed by the following list of operators (50,4 million total
active lines)

Exhibit 7: Active lines per operator 2015-2016

Source: Comisión Nacional de los Mercados y la Competencia (CNMC)

In 2000 the CMT (Telecommunications Market Commission) also regulated the number portability process by which a
subscriber can change his company keeping their phone number and completely free. Since the launch of the
procedure until April 2007, more than 9 million customers have switched operators, as much of the entire European
Union. CMT has approved a Circular Reference Entity established mobile network, which handles portability in fixed
network, through which all mobile operators can access a number of interfaces common and will be responsible for
recording the portability requests, incidents occurring during the process and transactions. In this architecture, the
CMT will have a monitoring interface, allowing you to access all the information stored in the Reference Entity (ongoing
processes, statistics, state of the numbering) and ensure that procedures are developed properly portability.

Portability is the possibility for the user to change their service provider without having to change the telephone
number they have. This possibility, which eliminates the inconveniences that users would otherwise suffer, facilitates
the change of operator and Spain is traditionally one of the countries in the EU with the highest portability indexes. In
2016, the average monthly for portability of mobile and fixed numbers have been 417,029 and 146,069 numbers
respectively, figures lower than those of 2015. (Exhibit 8). The trend from 2013 is that portability is decreasing.

Exhibit 8: Average Monthly Portability

Source: Comisión Nacional de los Mercados y la Competencia (CNMC)

Even though we have said that portability is decreasing, the following graph shows that Movistar was the only operator
of the three main companies that presented a negative net balance of fixed lines. Orange, after the purchase of Jazztel,
and Vodafone had a very similar positive net balance. The rest of the operators include those of the MASMÓV! L Group,
with a positive balance.
Exhibit 9: Net portability balance per operator (lines)

Source: Comisión Nacional de los Mercados y la Competencia (CNMC)

In December 2015, Telefonica unveiled its five-year plan towards becoming an 'Online Telco'. As part of the plan, the
company aims to upgrade its fixed and mobile networks and improve internet connectivity. In its European countries
of operation, its LTE coverage extends to 75% of the population. At the end of 2015, its LTE subscriptions tripled, while
its smartphone customers grew by 43%. Global mobile data revenue grew by 17% in 2015, as Telefonica expanded its
3G and 4G networks in Spain, Latin America and Germany.

Annual revenue was €47.2bn in 2015, a 9% increase over 2014. However, net income fell by 11% year on year, to
€2.9bn, as the company booked a one-time charge of €2.6bn in the quarter ended December 31st. This was related to
the restructuring of its domestic business in Spain, Telefonica España. Total expenses were up 21% to €37.6bn.The
company's operating income before interest, amortization and depreciation (OIBDA), a common measure of
profitability in the telecommunications sector, fell by 17% to €11.4bn, after factoring in the non-recurring impacts of
various acquisitions and disposals.

Telefonica's strategy in the past few years has been to invest in core markets such as Brazil, the wider Latin American
region and Germany, while also mounting a recovery in its home market of Spain. It will continue to focus on growing
its business in these markets by offering customers a bundle of services such as pay-TV, internet, fixed-line and mobile
services. It also intends to expand pay-TV operations across Latin America in the coming year and produce its own
content.

Conclusion

As a leading company in the telecommunications sector, Telefonica is and should be leveraged engine of the economy
and the industry in which it operates. But we should not miss the opportunity to secure this position. Quite the contrary
should go for ambitious business strategies that make them attractive commercial offers to continue gaining market
share. Must use its corporate capabilities, organizational and funding to maintain and even improve their position.
(Exhibit 6)
Exhibit 10: Capabilities Analysis

Production
R&D Sales & Distribution Service & Support
Operations

 Improved customer
 Standard
service. Personalized
processes
 Continuous service
 Certificate of  Simplification of the
innovation process  Own Call Center service
Processes quality commercial offer
 Increased  Focus on customer
 E2E business  Customer Loyalty
investment service (Engagement)
transactions
 Assumption of ITIL best
monitoring
practices

 Personal stress

 Employees with  Distributors that resistant

 Commitment to
high productivity capture customer  Quick reaction
People innovation profiles
 Employees with needs. capability to incidents
(Skills)  Highly qualified
eagerness of  High knowledge of  Proper organization
staff
overcoming the commercial offer  Clarity of leadership in
work teams

 Adequacy in the

 HW and SW  Minimizing shortest time possible

 Effective systems
System / pointer on which to impacts on successful with new systems
and distributed in
Tech build new services implementation deployed in production
retail stores
(Online Telco) productions with clear operational
providers for exploitation

 Permanent
tracking market for  Specialization by  Continuous
 Alignment with the
new acquisitions of business line improvement of
Alignment / brand image
technology and / or  Internal alignment operational processes
Sustainability  Making customer
knowledge with the business  Attractive Professional
trademark fans
 Staff aligned with areas Career for employees

corporate strategy
However, it is unquestionable stiff competition and consumer demand for lower prices posed a problem for Telefonica
in the future. It should make a strong commitment to customer acquisition and invest in 4G coverage this infrastructure
deployed throughout the national territory. The alliance with Telstra in this regard must be secured and more so
narrow.

Also you should bet to preserve the competitive advantage by offering a broad portfolio, but simplified, high-value
services that make differentiate themselves from competitors in quality service delivery.

As described above the competitive advantage that has taken advantage may be at serious risk if you opt for strategic
shift aimed at simplifying basically commercial, making this a great value choice for customers and drive cultural
change that puts the customer at the center of daily work, feeling this fundamental maxim for the Company. This
process must be the result of the belief that only through customer satisfaction and building strong relationships of
trust can achieve the growth objectives that the Company be dialed.

References

 https://tradingeconomics.com/spain/unemployment-rate
 https://www.cnmc.es/
 https://ditrendia.es/wp-content/uploads/2014/07/Ditrendia-Informe-Mobile-en-Espa%C3%B1a-y-en-el-
Mundo.pdf
 www.telefonica.es
 www.telefonica.com
 www.vodafone.es
 www.orange.com
 www.yoigo.es
 Deloitte, Nuevos retos y estrategias, Newsletter 2013